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VAT on the recovery of employee costs

Companies are often faced with the dilemma where employees are employed in one group entity, but another group entity pays the salaries of those employees. This is often a challenge brought on by practical reasons, amongst others, only managing one payroll system group-wide, instead of a separate payroll system for each company. The payor company then re-charges the salary costs of those employees to the relevant group company. One is often confronted with the question of what the value-added tax (VAT) consequences of the fee recovery are.

The Value-added Tax Act (VAT Act) imposes VAT on the supply of goods and services by any vendor made in the course or furtherance of the vendor’s VAT enterprise. Therefore, if a company supplies services in the form of employee-related recoveries, it would be liable to account for output VAT in respect of the supply of those services, if those services form part of its enterprise.

“Supply” includes performance in terms of a sale, rental agreement, instalment credit agreement, and all other forms of supply, whether voluntary, compulsory or by operation of law, irrespective of where the supply is affected. The broad construction of this expression means that most transactions subject to VAT will fall within the scope of this particular provision. “Services” are considered anything done or to be done, including the granting, assignment, cession or surrender of any right or the making available of any facility or advantage.

The VAT Act furthermore determines that where any vendor makes a taxable supply of goods or services to an agent who is acting on behalf of another person who is the principal for the purposes of the supply, the supply is deemed to be made to the principal.

The relevant issue to consider in these circumstances is the employment relationship. Does a company incur the employee costs as principal and then “on-charge” the costs to other group entities? Or, in the alternative, can the company be said to be an administrator, or so-called paymaster, for purposes of the payroll function? Therefore, how is the employment relationship defined? What is the substance of the employment relationship?

Suppose the employees are employed by company X (i.e. the contracts of employment are between the employees and company X). In that case, company X will be regarded as the principal recipient of the services supplied by the employees. Any recovery or on-charge of costs relating to such employees to another company will, under these circumstances, represent a charge for the supply of taxable services (the supply of the services of the employees) and will accordingly be subject to VAT.

On the other hand, where company X merely acts as the paymaster for the group, the respective employees will supply the services to the other group company as the principal recipient of the services. Under these circumstances, company X will be acting in the capacity of a paymaster. Compare this, for example, to a situation where a company does not have a bank account and cannot practically pay its employees – an administrative arrangement will have to be made for that company’s employees to be paid.

Importantly, any additional fee charged to a company, by company X, for payroll administration services (i.e. not a mere recovery of the employment costs) will constitute consideration for a taxable supply and be subject to VAT (which we understand is sot currently the case).

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

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